Free Cash Flow

Free cash flow (FCF) is operating cash flow minus capital expenditure: what is left after the business funds both its operating cycle and the reinvestment needed to keep itself running. It is the strictest common measure of cash generation, and for creditors it is the most honest one — FCF is the pool from which debt is actually repaid and from which a stressed company catches up on stretched payables.

FCF exposes what EBITDA hides. An equipment-intensive contractor can report $3M of EBITDA and near-zero FCF because machines must constantly be replaced; a software distributor with minimal capex converts most EBITDA to FCF. When assessing whether a customer can service debt or fund growth, the EBITDA-to-FCF conversion rate over several years tells you the business model's real cash yield. Persistent negative FCF is not automatically fatal — a genuinely growing company investing ahead of demand can run negative for years — but it means the company depends on external financing, and your exposure depends on that financing staying available.

One refinement for credit work: separate maintenance capex from growth capex when the customer can articulate the split. Negative FCF caused by a discretionary warehouse expansion is a different risk than negative FCF caused by operations that cannot cover routine equipment replacement. The first stops when management decides to stop; the second stops only when the business improves or the money runs out.